BONDS AND STOCKS RECOUPLING?

FED BATTLE AGAINST DEFLATION HELPS... A few weeks back the Fed expressed new concerns about the threat of deflation. As a result, they made it clear that their desire was to either keep interest rates low/ or at least keep them from rising. While most of the emphasis in the past was placed on short-term rates, recent focus has turned to longer-dated maturites -- namely T-notes and bonds. Since short-term rates can't drop much more, most of the downward movement in rates has come further out in the yield curve. That explains the recent upside move in the price of 10-year T-notes and 30-year T-bonds. The Fed has also hinted that they may buy longer-dated maturities to push long-term rates down further. That strategy has helped both bonds and stocks -- and may be signalling that the two markets are "recoupling" after being decoupled since 1998. The two charts below compare the price of the long bond with the S&P 500 over the past year. Until April, they were moving in opposite directions. Over the past month, bond and stock prices have been rising together. Even more impressive is the fact that both markets have broken out together. We take this is as a positive sign that falling long-term rates may finally be having a positive impact on the stock market and the economy. We also suspect that an oversold dollar is due for a bounce. That may come today if the Europeans lower their interest rates. That could also give a boost to U.S. bonds and stocks. MORE LATER

Chart 1

Chart 2